West Texas Intermediate futures rose above $122 a barrel, trading near a three-month high. Inventories at the nation’s biggest storage hub at Cushing, Oklahoma, fell 1.59 million barrels last week, according to an Energy Information Administration report Wednesday. Gasoline inventories also dropped while demand rose.

This week’s government inventory report showed “improvement in implied gasoline demand back to 5-year averages,” said Rebecca Babin, senior energy trader at CIBC Private Wealth Management. “Both technical and fundamental factors read positive,” she said, noting WTI appears to be holding $120, a level it’s failed to maintain over the past week.

Prices rose earlier in the session on signals that China’s economy is recovering. The prospect of Chinese demand improving means crude prices could keep rising, the UAE energy minister said earlier today at a conference in Jordan. The amount of oil that producers can add to the market “is not very encouraging,” Suhail Al-Mazrouei added, highlighting concerns about spare production capacity in the oil market.

The comments came after banks including Goldman Sachs Group Inc. and Morgan Stanley underlined calls for higher prices in the coming months.

Shrinking inventories of refined products at the start of summer underscore a fundamentally tight supply situation. The four-week average for gasoline demand rose to 9 million barrels a day for the first time this year following Memorial Day weekend, which is the traditional kick off to the summer driving season. Demand is rising even as the national average price for gasoline, already at a record, approaches $5 a gallon.

Diesel prices are surging faster than gasoline, with an unusually hefty premium for this time of year with the rest of the world is relying on the US to supply the most widely used oil product in Europe. An EU measure to forbid purchases of Russian refined petroleum products in the coming months is exacerbating an already tight fuel market.

The oil market has maintained its upward momentum this year as economies rebounded from the pandemic, though Russia’s invasion of Ukraine and a virus resurgence in China has led to extreme volatility. Beijing continues to roll back its Covid-19 curbs as infection rates ease. Last week, OPEC+ lifted output by more than it had previously planned, though the group has struggled to meet its targets in recent months.

Oil slipped as rising volumes of Russian crude headed to Asia countered bullish sentiment spurred by Saudi Arabia’s bigger-than expected price increase for deliveries to the Far East.

West Texas Intermediate dropped to settle at $118.50 a barrel after earlier touching a three-month high. Indian refiners are working on finalizing new six-month supply contracts for Russian crude, which if secured would be on top of the country’s existing purchases from Russia. This offset an earlier rally driven by Saudi Arabia’s boost  to its official selling prices to Asia, which the market interpreted as a signal of the kingdom’s confidence in demand.

“Energy traders are confident this oil market will remain tight given the short-term supply outlooks from both OPEC+ and the US, but it has been a steady climb higher,” said Ed Moya, senior market analyst at Oanda. “Exhaustion could be settling in.”

Oil has rallied over 50% this year as rebounding demand from economies recovering from the pandemic coincided with a tightening market after Russia’s invasion of Ukraine. Fuel markets have also tightened considerably, just as the peak period for US demand kicks off with the summer driving season. Retail gasoline prices have rallied to a record, while futures in New York hit a fresh high on Monday.

Last week, OPEC+ agreed to accelerate output increases following repeated calls by the US to pump extra volumes. The producer group said it would add 648,000 barrels a day for July and August, about 50% more than the increases seen in recent months. However, the group has struggled recently to meet its supply targets, raising doubts about whether it would be able to meet the goal.

Saudi Aramco raised its key Arab Light crude grade for Asian customers by $2.10 a barrel from June to $6.50 above the benchmark it uses. The market was expecting a boost of $1.50, according to a Bloomberg survey. The kingdom’s apparent confidence in Asian demand comes as China cautiously emerges from virus lockdowns that have strained its economy.

Meanwhile, Brent remains steeply backwardated, a bullish structure where near-dated contracts are more expensive than later-dated ones. The prompt time spread for the global benchmark touched $2.84 a barrel in backwardation earlier in the session.

Before Thursday’s OPEC+ meeting, oil had fallen on reports that Saudi Arabia and other members were prepared to fill the gap in the market created by Western sanctions on Russian oil, or even remove the country from the OPEC+ quota system altogether. Russia’s output has already fallen by about 1 million barrels a day since the start of the war and may drop further after the European Union agreed further sanctions on its oil. The policy shift eventually agreed upon by the Organization of Petroleum Exporting Countries and its allies was far less dramatic. The group approved oil-production hikes of 648,000 barrels a day for July and August, about 50% larger than the increases seen in recent months. Moscow gave the plan its full backing and talks were concluded in just 11 minutes, delegates said, asking not to be named because the information was private. The deal was “a pretty minor tweak,” said Farren-Price. Given the cartel’s recent struggles to hit its production targets, several analysts predicted that the additional volumes that would actually reach the market would be much smaller than the headline figure.

US Pressure

Opening the taps even just a little wider is still a turnaround for Saudi Arabia. The kingdom doggedly stuck to the OPEC+ plan for gradual monthly supply increases even after Russia’s invasion of Ukraine upended global markets and sent energy prices soaring. Last week, the Saudi foreign minister said there was nothing more the country could do to tame oil markets, and even suggested there was no shortfall of crude.

Thursday’s shift suggests that political pressure from the White House is bearing fruit. Joe Biden is likely to visit Saudi Arabia later this month, according to people familiar with the matter, a trip that would almost inevitably include a meeting with the kingdom’s effective ruler, Crown Prince Mohammed Bin Salman. The US president blames him for the 2018 murder of a US-based columnist, but with record high gas prices weighing on his party’s political prospects, pressure has grown on Biden to repair relations. “The United States welcomes the important decision from OPEC+ today to increase supply,” said White House Press Secretary Karine Jean-Pierre. “We recognize the role of Saudi Arabia as the chair of OPEC+ and its largest producer in achieving this consensus.”

The OPEC+ output increase will be divided proportionally between members in the usual way. Countries that have been unable to raise production, such as Angola, Nigeria and most recently Russia, will still be allocated higher quotas, meaning the actual supply boost may be smaller than the official amount — as has often been the case in recent months. Will the target increase actually translate into a meaningful uptick in the number of real barrels reaching the oil market?” Giovanni Staunovo, a strategist at UBS Group AG, wrote in a note. He estimated that “effective production increases will likely be about half of the target.”

Only Saudi Arabia and the United Arab Emirates have enough spare capacity to offset a significant portion of the supply gap created by sanctions on Russia. Much of that will remain untapped even after the July and August production increases, setting up a crucial OPEC+ meeting in two months that could determine whether the US and Europe persuade their Gulf allies to break further from Moscow.

“This does lay the groundwork potentially for a Biden visit at the end of the month, and maybe we could see some further increases from September onwards,” Amrita Sen, co-founder and research director at Energy Aspects Ltd., said in an interview. At the same time, “OPEC+, and particularly Saudi Arabia, want to continue with the group.”

Talk of a potential deal that would let other OPEC+ producers make up the crude supply gap left by Russia has put a lid on oil prices, but it would take much more to bring them down, analysts said.

“Exempting Russia from the OPEC+ output deal and allowing other producers such as Saudi Arabia to pump more might bring some temporary relief to the market, but the lack of sufficient spare capacity represents an increasingly binding constraint at a time of resurging postpandemic mobility,” said Edoardo Campanella, a Milan-based economist at UniCredit Bank, in a Wednesday note.

Factoring in output losses from Russia and assuming missing barrels from other OPEC+ countries remain unchanged would leave the cartel short of its goal by around 4.5 million barrels a day by July, he estimated. In other words, OPEC+ output would be the same as it was last August. In reality it will likely be lower, the economist said, because with the exception of Saudi Arabia, the United Arab Emirates and Iraq, all other OPEC+ producers have almost no spare capacity and would be unable to boost production as much as needed over the next two months.

Campanella said a deal to exempt Russia from the agreement on Thursday would likely have a short-term, negative effect on crude prices, but would be unlikely to last. Only scrapping the OPEC+ quotas altogether and a renewal of Iran’s nuclear accord would be sufficient to bring the market back into balance, he argued.

Have a Great Day,